Sorting Out Your Finances For Dummies by Barbara Drury

Author:Barbara Drury
Language: eng
Format: epub
Publisher: Wiley
Published: 2012-02-27T00:00:00+00:00

When you work out the return you expect from your investments, price in a premium for risk, plus a premium for inflation. For example, over a ten-year period, professional investors work on a nominal return from shares of around 4.5 per cent above the ten-year bond rate because shares involve more risk than bonds. If long-term bonds are returning income of 5.5 per cent, share investors should aim for a ten-year average annual return of roughly 10 per cent before taking inflation into account. If inflation is 2.5 per cent, you should look for an average real rate of return from shares of 7.5 per cent.

All investment involves a trade-off between risk and return. Taking no risks is one of the biggest risks of all. So, rather than trying to avoid risk, successful investors aim to manage risk through the careful selection and monitoring of their assets. Whether you manage your investments yourself or use a professional investment adviser is up to you.

The Rule of 72

If you want to start investing but have trouble visualising your puny financial acorn growing into a glorious tree, the Rule of 72 could provide inspiration. A simple calculation on the back of an envelope can help you determine how many years it will take your investment to double in value. You simply divide the number 72 by the percentage rate of interest you’re earning on your investment.

Imagine for a moment that Grandma has left you $25,000 in her will. You would like to use the money towards a deposit on a small apartment but you need closer to $50,000. Now think about what would happen if you put Grandma’s $25,000 into a savings account earning interest of 7 per cent a year — 72 divided by 7 is 10.2. So it will take a bit more than ten years for your $25,000 to double to $50,000. Of course, if you contribute to the savings account on a regular basis you’ll reach your goal much faster.

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